Monetary Policy and Fiscal Policy are two important tools of macroeconomic policy, which can be used to manage economy.

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Introduction

Introduction Monetary Policy and Fiscal Policy are two important tools of macroeconomic policy, which can be used to manage economy. The aim of the article is an outline the meanings of the terms fiscal and monetary policies, and how such policies affects the money supply, interest rates, and aggregate demand and so on. At the end, you will find out how fiscal and monetary policy should be used to raise the level of economic activity and there effectiveness in different situations will also be covered from the following content. What is Fiscal Policy? The Fiscal Policy can be used to overcome recession and control inflation. It may be defined as the government attempts to influence aggregate demand in the economy by regulating the amount of government expenditure and the rates of taxation. Figure 1 An increase in government spending will shift the aggregate expenditure line upward from AE to AE' and will lead to a higher level of output and employment, shown by the move from Y to Y' on the horizontal axis. Similarly, reducing taxes will make consumers have more money, a shift the aggregate expenditure line upwards, and increase output and employment. However, the effect of the cut in taxes is not as great as the effect of an equivalent increase in government spending. ...read more.

Middle

If it increases the quantity of money, the interest rate falls; if it decreases the quantity of money, the interest rate rises. The reasons that the central bank might want to change the interest rate, a low interest rate can active spending, particularly in investment; a high interest rate can reduce spending. By changing the interest rate, the central bank can change aggregate output (income). Expansionary Policy Any government policy aimed at activating aggregate output (income) is said to be expansionary. The effect of these policies would be to encourage more spending and raise the level of economic activity. Expansionary fiscal policy Government purchases and net taxes are the two tools of government fiscal policy. It can be used in various different ways. The government can influence the level of economic activity either by increasing government purchases or by reducing net taxes. It may be used to try to raise the level of economic activity when the economy in a recession, in this case it is called fiscal expansionary policy. An expansionary fiscal policy could include: 1. Cutting the lower, basic or higher rates of tax, 2. Increasing the level of government expenditure, Governments may choose to use expansionary fiscal policy in times of recession or a general downturn in economic activity. In this situation they will use their fiscal policy to give a boost to the economy. ...read more.

Conclusion

Extreme Keynesians support that only fiscal policy is effective, while extreme monetarists convinced that only monetary policy is effective. Research has shown that both two points of view are too extreme; both fiscal and monetary policy affects aggregate demand. When fiscal and monetary policies are used together. For example, in expansionary policy, policy aimed at increasing output and employment. Figure 3 Simply, expansionary fiscal occurred with expansionary monetary policy could mean that aggregate demand would be shifted to the further right. Prices would depend on the slope of the aggregate supply curve. This is illustrated in Figure3, where aggregate demand shift from AD0 to AD1, aggregate supply (AS) is moving up, the price level rises from P0 to P1, and output rises from Y0 to Y1. Consequently, expansionary fiscal and monetary policy working together are more effective than either working independently Conclusion In conclusion, it appears that government macroeconomic policy should be used carefully and with a well understanding of the consequences of the policies in the short and long run. Fiscal policies can have long-run effects on saving, investment, the trade balance and growth. Monetary policy can ultimately determine the level of prices and affect the inflation rate. The debate about which particular tool is most appropriate will continue, whereas most economists recognizes the advantages of using fiscal and monetary policy to prevent the recession in our economy or extreme inflation. ...read more.

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